Soft Wind Down and Segregated Portfolio Companies

The Court of Appeal's decision in ABC Company (SPC) v J & Co. Ltd (CICA Unreported, May 2012) ("ABC") is the first reasoned judgment of the Cayman Islands courts dealing with the winding up of segregated portfolio companies ("SPCs"). The decision endorses the assumption that underlies the use of SPCs in the Cayman Islands, namely, that insolvency of one portfolio will not impact the other portfolios so as to require a winding up order to be made over the SPC as a whole. Furthermore, and of particular note for the funds industry, the Court of Appeal has had its first opportunity to consider the circumstances in which it is appropriate to conduct a soft wind down by reference to the decision in Belmont1.

The petitioner brought a just and equitable winding up petition against ABC on the grounds that it had lost its substratum because one third of its segregated portfolios had suspended subscriptions and redemptions, including the single portfolio in which the petitioner was invested. The Court of Appeal, reversing Jones J's decision in the Grand Court, ordered the petition to be struck out on the grounds that it was bound to fail2. While expressly choosing not to decide the point, the Court of Appeal has indicated that future cases may require a review of the Belmont approach. Readers may recall that Belmont established that a fund cannot be said to be carrying on business as an open-ended investment fund within the reasonable expectation of its shareholders if its ability to redeem shareholders in cash and accept new subscriptions had been terminated. Although the Court of Appeal stopped short of overruling Belmont, it provides a salient reminder that, in determining a shareholder's "reasonable expectations", the Court will consider the representations made in the offering documents in light of the commercial reality, and that problems with liquidity (even over a moderate term) may not be sufficient to justify dissolution of an open-ended fund.

What is an SPC?

SPCs are a creature of Cayman Islands statute that were first introduced by amendments to the Companies Law in 1998. An SPC is a company which is permitted to create segregated portfolios in order to segregate the assets and liabilities held within or on behalf of a segregated portfolio from the assets and liabilities of the SPC held within or on behalf of any other segregated portfolio, or the general assets and liabilities of the SPC3. By use of this mechanism, creditors and shareholders only have recourse to the assets of the particular segregated portfolio with which they have contracted. Liabilities of one segregated portfolio, whether to creditors or shareholders, cannot be met by the assets of another portfolio, nor can they be met from the general assets of the SPC where this is prohibited in the articles of association, as is normally the case. The segregation of assets and liabilities within segregated portfolios does not create any new legal entities. The SPC is and remains a single legal entity and a segregated portfolio does not constitute a legal entity separate from the SPC itself.

The Court has jurisdiction to appoint official liquidators over an SPC as a whole either on the ground of insolvency or on the just and equitable ground. In respect of segregated portfolios that run into financial difficulties, shareholders and creditors can petition the Court to appoint a receiver over the portfolio in question on the basis that its assets are or are unlikely to be sufficient to meet its liabilities (i.e. on the grounds of insolvency). The receiver will then be appointed in order to manage the orderly closing down of the business of, or the distribution of assets attributable to the portfolio.

However, the legislation does not expressly provide for the appointment of a liquidator or receiver over an individual portfolio on just and equitable grounds relevant to the portfolio. Accordingly, if a segregated portfolio has suspended redemptions but it is still solvent, the Companies Law does not expressly provide an investor with any remedy in respect of the individual portfolio.

Application of soft wind down cases to ABC

The company, ABC, was an investment fund structured as an SPC. In February 2008, the company suspended the net asset value calculations for portfolios that were invested in real estate due to illiquidity which, under the company's constitutional documents, had the effect of suspending subscriptions and redemptions in those portfolios. Between May and October 2010, the shareholders, at over 60 class meetings, approved amendments to the articles of association which allowed the directors of the company to recommence the calculation of monthly net asset values, but separately suspend subscriptions and redemptions. The rationale was in part to allow for a secondary market for the shares to be generated. The company proposed to liquidate the real estate assets in an orderly manner for better value and return cash to shareholders over a two to three year period. The balance of the company's portfolios (representing 66% of the company's total net asset value) were operating normally and accepting subscriptions and redemptions in the ordinary course.

The petitioner held shares in one of the suspended portfolios and presented a winding up petition on the grounds that, as a result of the continued suspension of the real estate portfolios, the company had lost its substratum and therefore it was just and equitable that the company be wound up.

The petitioner relied entirely on the line of Cayman Islands authorities starting with Belmont and ending with Re Heriot African Trade Finance Fund Limited4. These cases are authority for the proposition that a fund cannot be said to be carrying on business as an open-ended investment fund if its ability to redeem shareholders in cash and accept new subscriptions has been terminated. In particular, these cases provide that a permanent suspension of redemptions followed by the investment manager liquidating assets and making a distribution to investors over time (i.e. a "soft wind down") is never within the reasonable expectation of investors without express language in the offering documents. It was said that such a fund has ceased to be viable as an investment fund as it is not in the ordinary course of business for a fund to suspend redemptions and for existing management to perform a liquidation exercise. In these circumstances, a fund will be considered to have "lost its substratum" making it just and equitable to grant a winding up order.

The company applied to strike out the petition on the grounds that it was bound to fail because, even if the Belmont line of authorities were correct, it could not be said to have lost its substratum where two thirds of its segregated portfolios were operating as normal. The Grand Court refused to strike out the petition on this basis because it was considered to produce a commercially unacceptable result that could not have been intended by the legislature. It was reasoned that on a true construction of the relevant sections of the Companies Law, the Court had jurisdiction to make a winding up order in respect of individual portfolios (as opposed to the SPC as a whole) or grant some alternative remedy (e.g. receivership) on the basis that an individual portfolio has lost its substratum or on other just and equitable grounds.

The company appealed. On appeal the petitioner conceded that the legislation did not permit an individual portfolio to be wound up and that the appointment of a receiver was only available on the grounds of insolvency and not on any just and equitable basis. Accordingly, the Court of Appeal did not need to decide these points. The petitioner accepted that the only remedy was to seek a winding up order in respect of the whole company (meaning all of the segregated portfolios).

The Court of Appeal held as follows:

The Court has no jurisdiction to grant the alternative relief to a winding up order that are available under section 95(3) of the Companies Law5 unless the Court is satisfied it would make a winding up order in the first place6;

It could not be said the company had ceased to carry on business in accordance with the reasonable expectation of its shareholders having regard to representations that were set out in the company's offering memorandum;

In order to determine the reasonable expectations of the company's shareholders it is necessary to have regard to the company's articles of association and offering documents;

In this case the articles of association originally permitted the suspension of net asset value but also permitted amendments to the articles of association with the votes of the requisite classes;

The articles of association had been amended by a special resolution of each class of participating shareholders to expressly permit calculation of net asset value with continued suspension of subscriptions and redemptions;

These amendments must be taken to reflect the wishes of shareholders generally and the petitioner had not challenged the validity of these resolutions;

In circumstances where the shareholders had voted to amend the articles of association to permit the suspension of redemptions and subscriptions, it could not be said that the subsequent suspension of redemptions in the real estate funds was outside the reasonable expectation of shareholders;

The offering documents also contained risk warnings that the liquidity of segregated portfolios could not be guaranteed and in some cases illiquidity may prevent redemptions and subscriptions;

The offering documents also contained statements that the directors may from time to time suspend redemptions at their discretion;

Any experienced investor must reasonably expect that a feature of an open ended investment fund is that illiquidity of the portfolios would lead to an inability to pay redemptions;

No informed investor reading the documents as a whole could fail to appreciate that the right to redeem its shares could be suspended;

There was no evidence that the liquidation of the real estate portfolios by the investment manager would be less advantageous to shareholders than if the liquidation was carried out by official liquidations pursuant to a winding up order; and

In these circumstances it was impossible for the petitioner to contend that the company has ceased to carry on business in accordance with the reasonable expectation of its shareholders.

The Court of Appeal reached this decision notwithstanding that there was no express wording in the offering documentation that permitted a soft wind down of individual portfolios to be carried out by the investment manager. This appears to contradict the conclusions of the Grand Court in Heriot and Wyser-Pratte which provide that in the absence of such wording, a soft wind down cannot be said to be in the reasonable expectation of shareholders.

However, the Court of Appeal expressly stated that, in the circumstances of this case, it did not need to decide whether the Belmont line of authorities was correct. Nevertheless, the Court of Appeal's comments appear to bolster arguments for funds seeking to resist a winding up petition brought by dissatisfied investors on the grounds of loss of substratum due to a suspension of subscriptions and redemptions.

In respect of SPCs, the decision provides confirmation that the SPC structure will be respected by the Courts in the context of a winding up petition where the offering documents and articles of association are clear in respect of the manner in which shares in segregated portfolios may be suspended. The mere fact that certain portfolios are suspended is not, of itself, sufficient to justify a winding up order being made in respect of the SPC as a whole. Please click here to download the full judgment.

5 i.e. an order regulating the conduct of the company's affairs; an order requiring the company to refrain from doing a particular act or to perform a particular act; an order authorising the petitioner to bring a derivative action or an order for the purchase of the shares of the petitioner